Chidambaram’s Challenge on New Reforms

India’s economic growth has eased to below 5%, inflation remains high and there are concerns over its wide fiscal and current account deficits.

India’s Finance Minister P. Chidambaram promised that the government would try to introduce more steps to boost the economy when the federal budget is discussed in Parliament this week, but analysts say sweeping new reforms are unlikely.

That’s because debate is likely to be dominated by the big-ticket reforms already up for discussion. These include easing foreign investment rules in the pension and insurance sectors, and approving the land acquisition bill.

Beyond those, Mr. Chidambaram doesn’t have much ammunition. At best, he’ll be restricted to small new measures such as easing foreign investment procedures and reducing the lock-in period on bond investments. These measures could help lift sentiment but, taken alone, they are unlikely to address the problem of an investment slowdown.

“You can announce as many steps as you want to boost sentiment, or to benefit some class of foreign investors. But what actually needs to be done is on the investment side, which won’t be addressed unless project clearances are speeded up,” said Nitesh Ranjan, an economist at Union Bank of India.

India’s economic growth has eased to below 5%, inflation remains high and there are concerns over its wide fiscal and current account deficits. Reforms have been slow, too, diminishing India’s investment appeal, while exports have taken a hit as demand drops in markets such as the U.S. and Europe.

The government has come under fire for failing to take timely corrective steps. But Mr. Chidambaram has revived the reform agenda since assuming office in August, implementing proposals such as allowing foreign multi-brand retailers to operate in India. He has also promised to maintain fiscal discipline.

Economists say the government could allow more foreign investment in local debt markets. There is a cumulative cap of $75 billion on foreign investment in government and corporate bonds. The limit has been increased before and could be lifted further to bridge the current account gap.

Such a move wouldn’t be without risks as it exposes India’s financial system to volatile capital flows that tend to return to safer regions in times of global turmoil, say economists.

The government could also try to boost exports when it unveils its annual trade policy, likely by end March, analysts say. Potential measures include extending cheap loans to exporting industries and discouraging imports such as of gold. In January, the government raised import tax on gold to 6% from 4% to reduce demand, and in February it suspended gold imports from Thailand that were attracting a low tax under a free trade agreement.

To get a meaningful recovery rolling, the government should focus on old reform promises, and it is expected to present the insurance, pension and land acquisition bills for lawmakers’ approval in the ongoing Parliament session.

It will try to push these bills through, but strong opposition on contentious steps like allowing foreign investments in pension fund management could prove a roadblock for the reforms. The government has proposed allowing up to 49% FDI in the pension sector and increasing the FDI cap in the insurance sector to 49% from 26%. In addition to attracting much-needed foreign capital, these reforms would also likely create job opportunities for India’s growing workforce, analysts say.

The government also needs to speed up an infrastructure overhaul. It is planning investment of about $1 trillion by 2017 to improve power supply, secure coal supplies, and build new ports and airports. Funding this won’t be easy.

Moses Harding, head of economic and market research at IndusInd Bank, says investment conditions won’t improve much unless the government takes steps to remove uncertainty related to land acquisition and simplifies processes for project implementation.

But local media reported last week that political parties are still divided over the contents of the land acquisition bill, indicating the Parliament might struggle to clear it this session.